HOW DOES THE LETTER OF CREDIT WORK?

A letter of credit is a banking instrument that allows a buyer to get a payment deferral on imported goods for a period of 60 to 150 days. This payment mechanism can also be used to involve a bank as a guarantor of the transactions in case partners are in different countries or for the first time enter into trade relations.

A letter of credit is one of the easiest and most convenient ways to make a transaction without serious risks for the participants. The bank acts as a third party and a guarantor, which regulates the payment acceptance and its further transfer only in case of the total compliance with the terms of the contract and provision of these reporting documents.

That is how the supplier is insured against non-payment after the shipment of goods and, on the other hand, the customer is guaranteed a complete range of services.
The letter of credit cannot be revoked. If the supplier has fulfilled the obligations and submitted all specified reporting documents to the intermediary bank, then the bank will transfer funds from its correspondent account simultaneously debit the same amount plus transaction commission from the customer's account.

If the goods are not delivered and the necessary documents are not presented to the bank, then the funds will not be transferred.

Just like all banking transactions, transactions with a letter of credit are regulated by the legislation adopted for international trade.

In which situations you need a letter of credit:

If the supplier always asks for a 100% prepayment, and you are not ready to withdraw the entire amount from your working capital;
If the transportation sector takes up too much time and you are not ready to freeze the funds for such a long period of time;
If you are working with a foreign partner for the first time and would like to have a guarantee of the full contract execution.
If you need a payment deferral to start realization of goods on time;
When working with letters of credit, companies apply "Uniform Customs and Practice for Documentary Credits" (or shortly UCP 600) outlined by the International Chamber of Commerce in 2007.
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LETTERS OF CREDIT CAN BE DIVIDED INTO:

By choosing a letter of credit as a form of payment you are easily able to multitask: make trade relations transparent and safe, develop business and constantly increase profits all at once.
having the bank as a third party. In this case, the bank acts as a guarantor of the contract payment, regardless of the actions of the issuing bank. It acts as the additional insurance of the transaction.

Confirmed letters of credit mean

when the bank notifies the exporter of the L/C issuing, and the payment is made only after the importer transfers the required amount.

Unconfirmed letters of credit occur

the type of letters, at the establishment of which the issuing bank is obliged to transfer the amount of L/C at the expense of the payer or the loan granted to him to the account of the performing bank for the entire term of the obligations.

Covered letters of credit are

those, at the establishment of which the executing bank is given the right to debit the entire amount of the L/C from the current account of the issuing bank.

Non-covered letters of credit are

the full amount of the transaction, but only the executed part, i.e. the funds are transferred to the account according to their expenditure. It is highly advantageous when conducting regular transactions.

Revolving L/Cs don't cover

L/Cs, that are paid in case of buyer's failure to pay for the shipped goods. This is one of the types of bank-issued guarantees used in international trade.

Stand-by letters of credit are

As s result - trilateral benefit

The supplier starts production or shipment of the goods from the moment of confirmation of the letter of credit.

The importer receives a deferred payment and insures himself against the payment of non-compliant goods or non-performance of production obligations. A letter of credit is truly helpful in its ability to pay for goods without withdrawing its own funds from the company's turnover until the goods are supplied to the warehouse.
Banks benefit from letters of credit because of both greater transaction commissions and the ability to provide a new quality service. Therefore, it helps to increase the customer base.
The supplier starts production or shipment of the goods from the moment of confirmation of the letter of credit.